As the Cereal War Heats Up, Kellogg Reduces Prices

By BARNABY J. FEDER

Published: June 11, 1996

The Kellogg Company wheeled out the heavy artillery in the cereal war yesterday, announcing price cuts averaging 19 percent on Frosted Flakes, Raisin Bran and 14 other cereals, representing two-thirds of its domestic cereal sales.

Kellogg's move came after scanner data from supermarket checkout lines warned the company that its industry-leading market share was eroding rapidly in the face of the across-the-board 20 percent price cuts announced earlier this spring by Post and Nabisco cereals, the subsidiary of the Philip Morris Companies that ranks third in the industry after Kellogg and General Mills Inc.

We had been planning to make these reductions by year end but decided to move them up," said Arnold G. Langbo, chairman and chief executive of Kellogg, which is based in Battle Creek, Mich.

Kellogg warned Wall Street that the price cuts would sharply reduce earnings per share in the quarter ending this month and make it unlikely that profits for the whole year would exceed 1995.

While the cuts did not apply to such popular brands as Kellogg's Corn Flakes, Special K, Rice Krispies and Crispix, they are expected to slice about $350 million off of revenues this year.

Kellogg's shares, in turn, fell $2.875 to close at $72 on the New York Stock Exchange. Volume was heavy, at 1.3 million shares traded.

Analysts said that Kellogg's price cuts would put pressure on General Mills, the Quaker Oats Company and Ralcorp Holdings Inc. to make price reductions of their own, although not necessarily as broad or deep. Ralcorp, which makes Chex cereals and is the leading manufacturer of cereals sold under store labels, has already been hurt by the contraction of the gap between the major-branded cereals and its private-label business. It announced plans yesterday to lay off 100 workers as part of an effort to reduce its annual costs by at least $25 million.

"At this point, the only thing that is clear is that the category is in the midst of a very costly price war and that our Ralston Foods franchise, as well as the entire cereal industry, will be negatively impacted," said Richard A. Pearce, chief executive of Ralcorp, which is based in St. Louis. "The actions we are taking assumed a competitive response comparable with that announced by Kellogg."

How much consumers will benefit depends on what brands they buy and how careful they are to clip coupons and exploit in-store promotions. Kellogg's price-cutting plans are accompanied by a drive to reduce its promotional spending.

"I would guess that the net price decrease is in the 5 percent to 8 percent range," said John McMillin, who follows the industry for Prudential Securities.

General Mills, which began the price cutting two years ago, said it had no immediate plans to follow Kellogg. Quaker said that its products were lower priced on average than its competitors and that it would continue to emphasize its bagged cereals as the best option for cost-conscious consumers.

What the industry and those who follow it on Wall Street are really looking for is some sign that the price cutting is stimulating demand for cereal. The cereal war began two years ago when the companies started searching for ways to grapple with stagnating demand in the nearly $9 billion industry. Consumers had become fed up with constantly increasing prices and the cost of trying to attract them with coupons and other promotions was soaring.

The price cuts had the desired result for Post and Nabisco, which have seen their market share rocket from about 16 percent to more than 20 percent. If that increase is sustained, it could add almost $400 million to the company's annual sales. But just how much was due to the price cuts is hard to say, because Post and Nabisco were also spending heavily on promotions that are due to end this month.

Moreover, most of what Post and Nabisco gained did not represent new consumer interest in cereal but sales taken out of the hide of Kellogg, the company with the most similar products. Analysts estimate Kellogg's market share fell to less than 32 percent from more than 35 percent in the latest month for which figures are available.

"The next benchmark for the entire category is whether this move by Kellogg invigorates sales," said Michael Mauboussin, an analyst at CS First Boston.

If it does not, Wall Street is likely to remain leery of the cereal makers. Kellogg, the industry leader, has trailed the stock market in three out of the last four years, as measured by the performance of the 500 stocks in the Standard & Poor's index. And this year, Kellogg's shares are down about 8 percent while the S.& P. 500 index has risen 9.13 percent.

Graph: "A Less-Than-Great Market" shows the 52-week change insupermarket sales of ready-to-eat cereals, based on sales for the 52 weeks ended April 21 and February 25. (Source: Information Resources Inc.)